236 CHAPTER 6. THE MARKET FOR CURRENCY FUTURES
Sincef≈F, it follows that the basis is positive (i.e.futures prices are above spot
prices) if the foreign rate of return is below the domestic one, andvice versa.
6.4 Hedging with Futures Contracts
In this section, we see how one can use futures to hedge a given position. Because of
its low cost even for small orders, a hedger may prefer the currency futures market
over the forward market. There are, however, problems that arise with hedging in
the futures market.
- The contract size is fixed and is unlikely to exactly match the position to be
hedged. - The expiration dates of the futures contract rarely match those for the currency
inflows/outflows that the contract is meant to hedge. - The choice of underlying assets in the futures market is limited, and the currency
one wishes to hedge may not have a futures contract.
That is, whereas in the forward market we can tailor the amount, the date, and the
currency to a given exposed position, this is not always possible in the futures mar-
ket. An imperfect hedge is called across-hedgewhen the currencies do not match,
and is called adelta-hedgeif the maturities do not match. When the mismatches
arise simultaneously, we call this across-and-delta hedge.
Example 6.9
Suppose that, on January 1, ausexporter wants to hedge asek9,000,000 inflow
due on March 1 (=T 1 ). In the forward market, the exporter could simply sell that
amount for March 1. In the futures market, hedging is less than perfect:
- There is nousd/sekcontract; the closest available hedge is theusd/eurfutures
contract. - The closest possible expiration date is, say, March 20 (T 2 ).
- The contract size iseur125,000. At the current spot rate of, say,sek/eur9.3,
this meanssek1,162,500 per contract.
So assuming, irrealistically, a constantsek/eurcross rate, the hedger would have to
sell eight contracts to approximately hedge thesek9,000,000: 8× 1 , 162 ,500 = 9.3m.
But the more difficult question is how to deal with the cross-rate uncertainty and
the maturity mismatch. This is the topic of this section.
As we shall see, sometimes it is better to hedge with a portfolio of futures con-
tracts written on different sources of risks rather than with only one type of futures
contract. For example, theoretically there is an interest risk in bothsekandusd
because the dates of hedge and exposure do not match, so one could consider taking